Covered Call Strategy Explained

What if your long-term stock holdings could generate regular income, even when markets are not moving much? That’s exactly what the covered call strategy aims to do.

Popular among conservative and income-focused investors, this options strategy allows you to earn additional returns by selling call options on stocks you already own.

In this guide, we’ll explain what is covered call strategy, how it works in the Indian stock market (NSE), its objectives, features, pros and cons of covered calls, and the regulatory and practical realities every Indian investor must understand before using it.

What is a Covered Call Strategy?

A covered call strategy is a conservative yield-enhancement approach commonly used by investors who already own shares of a company. The strategy involves holding the underlying stock while simultaneously selling a call option on the same stock.

This strategy consists of two components:

1. Long Position in Shares: The investor owns a specified quantity of shares, typically at least one full market lot as defined by the exchange.
2. Short Position in a Call Option: The investor sells (writes) a call option against those same shares, agreeing to sell them at a predetermined price if required.

Why Is It Called a “Covered” Call?

When an investor sells a call option, they take on the obligation to deliver shares at the strike price if the option buyer chooses to exercise the contract.

If the investor does not own the shares, the position is known as a naked call, which carries significant risk because the stock price can rise without limit.

If the investor already owns the shares, the position is considered covered. The shares held in the Demat account serve as collateral and can be delivered if the option is exercised.

This ownership of the underlying stock substantially reduces the risk associated with selling call options.

The “Synthetic Dividend” Concept

A covered call strategy can be viewed as a way to generate a synthetic dividend from a stock.

By selling the call option, the investor receives an upfront premium in cash. This premium provides immediate income, similar to a dividend payout. In return, the investor agrees to limit the potential upside of the stock beyond the chosen strike price.

In essence, the investor earns additional income today in exchange for sacrificing a portion of future gains if the stock price rises sharply.

How Covered Calls Work?

To understand how a covered call strategy works in practice, let us look at an example using a large, liquid NSE-listed stock.

The Setup:

• You Own: One Market Lot of an NSE stock (e.g., Reliance Industries).

Note: As of late 2025, NSE lot sizes have been revised; for many large-caps, the lot value is aimed at ₹15–20 Lakhs.

• Current Market Price (Spot): ₹1,565 per share (illustrative).
• Total Investment Value: Spot price × number of shares in one lot.
• You Sell: One out-of-the-money (OTM) call option, typically with a strike price of ₹1,650.
• Option Premium Received: ₹10 per share (illustrative).
• Immediate Premium Credit: ₹10 × Lot Size (e.g., if the lot is 500, you get ₹5,000).

Capital & Margin

When you sell a call, you receive the premium, but exchanges require an upfront margin. The exact margin depends on the stock, lot size, and the exchange’s margin framework. Brokers may allow you to pledge shares as collateral, but you will usually need some liquid cash in your ledger to meet cash‑to‑collateral requirements. The ₹2L–₹3L figure used earlier is illustrative; calculate margin using your broker’s margin calculator for the specific lot and date.

Three Possible Outcomes at Option Expiry

In September 2025, the NSE shifted the Monthly Expiry from Thursday to Tuesday. At expiry, one of the following scenarios will occur:

The sideways market scenario is the most favourable, as the investor earns income without losing ownership of the shares.

Key Practical Considerations for Indian Investors

1. Physical Settlement of Stock Options and Expiry Timing: India uses physical settlement for stock options, which means in‑the‑money calls at expiry result in delivery of shares. Exchange calendars and expiry conventions have changed in recent years; confirm the current monthly expiry day on the NSE calendar. Brokers typically begin blocking additional delivery or extreme‑loss margins in the days leading up to expiry, which can increase margin requirements as expiry approaches.

2. Transaction Cost Leakage: The option premium is not pure profit. After STT, exchange charges, GST, broker fees, and other levies, the net premium will be lower than the headline premium. The example “₹10 → ₹8.50” is illustrative; compute net take‑home using your broker’s fee schedule and the applicable taxes for the trade date.

3. The Lot Size Barrier: In India, you must sell options in full market lots as defined by the exchange. SEBI and the NSE have revised contract values in recent years, and for many large-cap stocks, a single lot can represent a substantial notional value (often in the multiple‑lakhs range). Because lot values change, treat any ₹15–₹25 lakh figure in this article as illustrative; check the current lot size for each stock on the NSE website before implementing this strategy.
4. How to verify: Check the NSE circulars and your broker’s margin calculator for current lot sizes, expiry dates, and margin requirements.

Objectives of the Covered Call Strategy & Examples

The primary goal of a covered call strategy is yield enhancement, not aggressive capital appreciation. It is designed to turn a "static" asset (shares) into an "active" income generator.

1. Income Generation (The "Synthetic Dividend"):

The most common objective is to collect the option premium. For many Indian blue-chip stocks that pay low dividends (e.g., tech stocks like TCS or Infosys), selling a covered call can generate an additional 1%–2% monthly yield, effectively creating a monthly "paycheck" from your portfolio.

2. Improving Returns in "Quiet" Markets:

In a sideways (range-bound) or mildly bullish market, a stock’s price might not move for months. In this scenario, a buy-and-hold investor makes 0% returns. A covered call investor, however, earns the option premium, significantly outperforming the underlying stock.

3. Lowering the "Break-Even" Price:

Every time you collect a premium, you effectively reduce the cost of your investment.

Example: If you bought Reliance at ₹2,500 and collected a ₹50 premium, your net cost drops to ₹2,450. This provides a small "cushion" if the stock price dips slightly.

4. Monetising Idle Long-Term Holdings:

Many Indian investors hold stocks for decades. If you have no intention of selling your "core" holdings for years, selling a far Out-of-the-Money (OTM) call allows you to earn rent on that "digital real estate" while you wait.

5. Target Selling (Exiting a Position):

Sometimes, an investor wants to sell their shares at a certain price.

• The Strategy: Instead of placing a standard "Limit Sell" order at ₹2,600 and waiting, the investor sells a ₹2,600 Strike Call.
• The Result: If the stock hits ₹2,600, they sell the shares as planned, but they also get to keep the option premium. It is a way of "getting paid to sell your stock."

6. Portfolio Volatility Dampening:

By collecting a premium, the total value of your portfolio fluctuates less than the market. When the stock goes down, the value of the call you sold also goes down (which is a profit for you), partially offsetting the loss on your shares.

Key Features of the Covered Call Strategy

1. Risk Mitigation (Vs. Naked Calls): The defining feature of this strategy is that it is "Covered." If the stock price skyrockets, a "Naked" call seller faces unlimited losses. However, you already own the shares. Your risk is not the price of the stock rising; your risk is simply being forced to sell your shares at the agreed-upon price.

2. Capped Upside Potential: This is the "Opportunity Cost" feature. Once the stock price hits your strike price, your profit stops growing. Even if the stock rallies 50%, you only keep the gains up to the strike price plus the premium received.

3. The Capital Barrier (SEBI Lot Size Rules): In the Indian market, you cannot sell a call against 10 or 20 shares. You must own one full market lot.

• The 2025 Reality: SEBI recently increased contract values. For most liquid stocks, a single lot is now worth between ₹15 Lakhs and ₹25 Lakhs.
• Implication: This is not a "micro-cap" or small-retail strategy; it is designed for well-capitalised investors or HNIs.

4. Margin Efficiency through Pledging: A unique feature in India is the ability to pledge.

• You don't need to keep ₹20 Lakhs in cash to sell the call. You can pledge your existing shares with your broker to get "Collateral Margin."
• Note: You will still need a small amount of "Liquid Cash" (usually 50% of the required margin) to satisfy the exchange's cash-collateral requirements.

5. "Theta" Decay: The most important feature of selling calls is Time Decay (Theta). As the expiry date (the last Tuesday of the month) approaches, the value of the call option you sold naturally decreases (assuming the stock stays flat). This "decay" is what puts money in your pocket. As the seller, you want the option's value to drop to zero by expiry.

6. Low Portfolio Volatility: A covered call position generally has a lower Beta (volatility) than a pure stock position. Because the premium acts as a buffer, your portfolio won't drop as fast as the market during a small dip. It provides a "smoother ride" for conservative investors.

Pros and Cons of the Covered Call Strategy

While covered calls are often considered a conservative options strategy, they are not risk-free. Understanding these pros and cons of covered calls is crucial before implementation.

Conclusion

The covered call strategy is a disciplined income-generating tool for Indian investors who already own quality stocks and understand options basics.

While it limits upside, it offers:

• Predictable income
• Better capital efficiency in flat markets
• A structured approach to call writing in the stock market

However, due to physical settlement, lot sizes, and tax implications, it is best suited for experienced or well-capitalised investors.

Disclaimer: Trading options involves risk. Covered calls require sufficient capital, margin, and understanding of physical settlement rules. Always verify current NSE lot sizes and consult a financial advisor if unsure.

FAQs Covered Call Strategy

1. What does a covered call ETF mean?

A covered call ETF invests in stocks and systematically sells call options to generate income.

📌 Important for Indian investors:

Active covered call ETFs are currently very rare or non-existent in India, unlike US ETFs such as JEPI or QYLD. Most Indian investors must DIY by holding stocks and writing calls manually.

2. What is call writing in the stock market?

Call writing means selling a call option to earn premium income. When backed by actual shares, it becomes a covered call; otherwise, it is a naked call, which carries much higher risk.

3. What is a cover call strategy best suited for?

A covered call strategy is best for:

• Sideways markets
• Income-focused investors
• Long-term stockholders who are willing to cap upside